Sliding yields signal further cut

Thanks to a surplus cash in bank vaults and weak credit demand from the private sector, demand for treasury securities remains perfectly stable in Pakistan, regardless of interest rate movement. However, when it comes to deciding investment tenure, savvy investors mostly chase interest rate direction. The high-level of participation in 12-month paper substantiates the market perception that a further cut in the discount rate is inevitable. On average, the 12-month paper accounted for 59 percent of the total participation in all auctions held since the start of the current fiscal year, as opposed to 16 percent (of the total participation level) in 1QFY11. At the same time, the average participation level in 3-month paper petered out to 9 percent versus 57 percent in 1QFY11. Investors are slightly dicey on the timing of the expected change in the discount rate, with majority expecting a cut in the next monetary policy, which will likely be announced during the last week of this month. The State Bank of Pakistan (SBP) had reduced the discount rate by 50 basis points to 13.5 percent in the last monetary policy after maintaining the status quo in the preceding three policy meetings. The market foresees further cuts in the policy rate during the current fiscal year; however, they don't expect inflation to fall to the extent that would give sufficient reason to cut interest rates below 12.5 percent. In light of strong demand for 12-month paper, its cut-off yield declined more steeply than 3-month and 6-month paper since the start of the current fiscal year. In the last auction, the spread between cut-off yields on 12-month and 3-month papers stood at 33 basis points. The yield curve is also sloping downward, with longer tenure securities trading at lower yield than shorter tenure ones; the yield on 10-year paper is hovering around 13.18 percent as opposed to 13.38 percent for 12-month paper. Monetary easing is a welcome development for the business community. But it will also reduce financing cost for the government, whose total borrowing from treasury securities, PIB and Sukuk, jumped 38 percent in the last one year. Then again, it would be unwise to start counting chickens before they hatch.. If the current floods are mismanaged, food prices may spiral, stoking inflation. If that happens the central bank may once again put a halt to the trend of falling rates.